The Lost Capital Asset Pricing Model

A flat Securities Market Line is not evidence against the CAPM. In a rational-expectations economy in which markets are not informationally efficient, the CAPM holds but is rejected empirically (Type I Error). There exists an information gap between the empiricist and the average investor who clears the market. The CAPM holds unconditionally for the investor, but appears flat to the empiricist who uses the correct unconditional market proxy. This distortion is empirically substantial and offers a new interpretation of why “Betting Against Beta” works: BAB really bets on true beta. The empiricist retrieves a stronger CAPM on macroeconomic announcement days.